While You Were Sleeping: Tinkering with the EITC

August 10, 2010

Last week was an active one for America’s stealth anti-poverty policy--the Earned Income Tax Credit (EITC)--though you’d be forgiven for not noticing. A couple of decisions, made with little fanfare, should have big implications for how low-income taxpayers receive the credit in the future.

The first development was a little disappointing. After a more than 30-year run, Congress seems poised to do away with the Advance EITC, to help offset a new round of federal aid to states. The Advance EITC is a little-used mechanism by which workers can get a portion of their expected EITC through their paycheck throughout the year. Under the program, employers can advance their workers up to $35 a week in credits, and then offset those payments against their payroll tax. But for a host of reasons, the Advance EITC never caught on with more than 1 percent of eligible filers, and the GAO found that the program suffered from a high degree of error. Our own research on the subject concludes that the design is so flawed, it’s probably best to scrap it and start over.

Emphasis on “start over.” With the expansion of the EITC and other refundable tax credits for families with children, more and more low-income filers are getting a significant amount of their annual earnings via a tax refund. It’s time to ask whether we’re really alleviating poverty, and “making work pay,” to use President Clinton’s phrase, when a low-earning mother with three children can receive upwards of half her annual income in a lump sum at tax time. These working families have pressing ongoing needs for food, shelter, and clothing, the bills for which don’t come due just once a year. The fact that so many of these taxpayers use expensive “rapid refund” loans to access these dollars just a few days before the IRS would deliver them testifies to the severe liquidity problems they face (more on that below).

The demise of the Advance EITC should obligate us to find a new and better way to pay the EITC periodically, throughout the year. Other industrialized countries with “in-work” tax credits--the U.K., Ireland, Australia, New Zealand--pay them directly to eligible families (not through employers) on at least a monthly basis. We’ve figured out how to do periodic tax payments, or may soon have to, to provide subsidies for health insurance, and for offsetting the impacts of climate change legislation on lower-income households. There are some tricky questions to contend with, including how to protect taxpayers whose circumstances change unexpectedly during the year from having to repay significant amounts. But we can strategically minimize the cost of those allowances, and the benefits of offering families real financial help throughout the year would far outweigh those costs.

Last week’s other notable, more positive EITC development was IRS’ decision to suspend availability of the “debt indicator” next tax filing season. This indicator, provided to tax professionals, enables preparers to identify whether or not the taxpayer’s refund will be reduced via an offset for federal debts, such as prior-year taxes owed or student loan arrears. Sounds innocent enough, but the debt indicator essentially enables preparers to make those high-priced, essentially risk-free refund loans, most of them to low-income taxpayers who receive the EITC. Without it, the rapid-refund business will probably (hopefully) die a quick death.

That’s a good thing for low-income taxpayers, though it won’t necessarily do much to improve the dire financial conditions that drive some of these families to refund loans in the first place. With deficits as far as the eye can see, it’s not clear that we’ll be able to increase the EITC or other low-income credits significantly in the near future. In the meantime, getting more of the money to families throughout the year is a meaningful step we can take toward improving their financial security.